An experimental investigation of the ‘tenuous trade-off’ between risk and incentives in organizations

Abstract

We investigate experimentally the relationship between risk and incentives in a principal-agent setting. In contrast to the existing empirical literature that describes such relationship as 'tenuous' or inconclusive, we find a clear negative relationship-supporting the prediction of the standard theoretical model. Specifically, we find that principals reduce the size of the offered piece rates with an increase in risk and instead provide positive fixed wages. Furthermore, we find no relationship between the variance in the performance and the effort choice of the agent, and a strong positive relationship between the effort choice of the agents and the offered piece rates as well as fixed wage, suggesting positive reciprocity. Finally, we find evidence of social projection by the principals regarding the agents' degree of risk aversion.

The roles of risk preferences, selection, and uncertain returns on land contracts

“…The relationship is insignificant or positive when evaluated on samples of executives (Aggarwal & Samwick, 1999; Core & Guay, 1999; Oyer & Schaefer, 2011) or franchisees (Martin, 1988; Lafontaine, 1992) and generally positive in samples of sharecroppers (Rao, 1971; Allen & Lueck, 1992b;1995). In contrast, the predicted negative relationship has been found in experimental settings (Corgnet & Hernán‐González, 2019; Chowdhurry & Karakostas,2020). The disagreement between experimental and econometric findings merits a reexamination of the empirical methods.…”

Tracking the pressure: The effect of monetary incentives on effort, emotions, and performance.

“…Consistent with the theory above, most of these studies have found that monetary incentives trigger more effort. However, several have found that this effort has failed to translate into better performance (see, e.g., Chowdhury & Karakostas, 2020; Cole et al, 2018; Etchart-Vincent, 2006; Gignac, 2018; Huillery & Seban, 2021; Mohd-Sanusi and Mohd-Iskandar, 2007).…”

“…A large body of empirical and theoretical literature has analyzed the relation between incentives, cognitive effort, and task performance. On the empirical front, several studies have found that monetary incentives are effective in triggering more effort but do not necessarily improve performance (Chowdhury & Karakostas, 2020; Cole et al, 2018; Etchart-Vincent, 2006; Gignac, 2018; Huillery & Seban, 2021; Mohd-Sanusi and Mohd-Iskandar, 2007). Explanations for this lack of effect on performance refer to tasks that require enormous amounts of effort (Westbrook & Braver, 2015) or individuals with large skill deficits (Bonner & Sprinkle, 2002).…”

“…2For review, see Bonner and Sprinkle (2002), Botvinick and Braver (2015), Kool and Botvinick (2018), Shenhav et al (2017), Westbrook and Braver (2015), and Yee and Braver (2018). Specific empirical contributions can be found in Belle and Cantarelli (2015), Chowdhury and Karakostas (2020), Cole et al (2018), Dunne et al (2019), Etchart-Vincent (2006), Gignac (2018), Huillery and Seban (2021), Ličen et al (2016), Mohd-Sanusi and Mohd-Iskandar (2007), Vassena et al (2014, 2019). …”

Reference points and the tradeoff between risk and incentives

“…However, these studies do not assess how changes in exogenous risk affect contract choice. Recent experimental studies by Corgnet and Hernán-González (2019) and Chowdhury and Karakostas (2020) manipulate output risk by introducing additive random shocks to production in order to examine whether principals respond to changes in output risk by adjusting the fixed and variable components of the contracts they offer to agents. Consistent with classical principal-agent models, both studies find that principals offer lower variable payment when output risk increases, particularly when principals believe that the agent is risk averse.…”